In the current debate about monetary policy, two terms are bandied about to the detriment of clarity: ‘printing money’ and ‘helicopter money’ (Sinn 2011).
To describe quantitative easing as ‘printing money’ is a misnomer. The amount of currency held by the public is determined by demand. When the Bank of England carries out quantitative easing, it pays for the bonds by crediting the seller’s bank. There is an increase in base money in the form of bank deposits at the central bank, but the demand for currency hasn’t changed. There is no need to ‘print money’.
An individual bank with excess holdings of deposits at the Bank of England might try to reduce these by creating new credit or buying other assets. But whatever individual banks do, the total amount of base money remains unchanged.
The image of the central-bank helicopter dropping currency onto the eager public below is even more misleading. Governments can do this, giving away either cash or, more realistically, cheques (the Australian government sent cheques to most taxpayers in 2009, dubbed the ‘cash splash’). But this is fiscal policy, not monetary policy. Central banks have no mandate to give money away (they can only exchange one asset for another, as they do in quantitative easing). Decisions like this are backed by the usual budget-approval process. Thus it is a government helicopter that does the drop, and it is called fiscal policy.
As usual, there are disagreements about how effective this would be in stimulating demand. Unless there is strong crowding-out or Ricardian equivalence – very unlikely when there is spare economic capacity and interest rates are held down by monetary policy – or, indeed, this deficit can’t be funded – clearly not currently applicable, with bond yields historically low – then this is very likely to boost demand. The recipient of the largess might save some, but will spend most. Thus those who explore this policy option are doubtless correct in arguing that fiscal expansion would provide a more assured boost to demand than would quantitative easing.
Funding the deficit
If there is a concern that normal funding through bond issuance might push up interest rates or that financial markets might baulk at the funding requirement, the central bank could fund the deficit, taking bonds into its balance sheet and crediting the government’s account. This is, to all intents and purposes, a quantitative easing operation, although it might be initiated by the government.
Who is bearing the cost of funding the budget deficit? When the government draws down its account at the central bank to write cheques to the public (the ‘cash splash’), these cheques are paid into banks. Even in the fantasy world of a helicopter currency drop, this ends up being deposited with banks, as the public already has all the currency it wants to hold. The banking system has more deposits from the public on its liability side, and more deposits with the central bank on the assets side. The deficit has been funded by forcing the banks to hold more base money.
Thus this approach doesn’t avoid an increase in official debt (the central bank’s increased liability to the banks has to be counted). Similarly, if the central bank pays a market interest rate on these deposits (which most central banks currently do), then it’s not even saving any funding cost. If the central bank ceases paying a market return on these deposits, that would lower the interest cost of funding the deficit, but it would be a de facto tax on banks.
There are subtle differences between this deficit-funding operation and normal quantitative easing. First, central banks decide when to do quantitative easing and how much, while an overt monetary finance would be a joint decision with the government. This raises issues of central-bank independence: the ability to say ‘no’ to government requests for funding is an important discipline on budget expenditures. There may also be a different understanding in financial markets about the unwinding of this operation. The clear understanding is that quantitative easing will be unwound at some stage, while with overt monetary finance this might be unclear (although the distortionary impact of the banking system’s forced holding of substantial excess reserves doesn’t seem to be a satisfactory long-term arrangement).
Lord Turner (2013) is right in criticising the inflation alarmists, who carry outdated views on the relationship between money and prices. Similarly, those with a deficit fetish who argue that stimulus will be futile and harmful should be required to make their case within the current context of spare capacity. Lord Turner’s cautious case for overt monetary finance needs to be balanced by considering the distortions that quantitative easing (and potentially overt monetary finance) has on bank balance sheets, as well as the damage to central-bank independence.
Sinn, Hans-Werner (2011, “The threat to use the printing press”, VoxEU.org, 18 November.
Turner, Adair (2013), “Debt, Money and Mephistopheles: How do we get out of this mess?”, speech, Cass Business School.